When you begin a major project with an underestimate of the cost and an overestimate of the benefits, coupled with the mandate to deliver on time and on budget, you run the risk of promoting unethical behavior.
In their Harvard Business Review article, Delusions of Success: How Optimism Undermines Executives’ Decisions, Dan Lovallo and Daniel Kahneman, 2002 Nobel Prize Winner in Economic Sciences, conclude that most “large capital investment projects come in late and over budget” primarily due to over optimism, traced back to cognitive biases, “errors in the way the mind processes information”, and to organizational pressures.
They argue that one of the most prevalent cognitive biases is anchoring, where the project forecasters use the initial plan, from a pre-feasibility or feasibility study, for the financial analysis. This plan, as the authors suggest, is skewed toward the positive, which could result in an overoptimistic cost estimate and an overstating of benefits. They refer to this approach as the inside view.
Lovello and Kahneman suggest that one way to minimize personal and organizational sources of optimism is to utilize a technique referred to as reference class forecasting. In this method the forecaster uses a class of similar projects and a distribution of their outcomes to arrive at a more realistic assessment of cost and benefits for the current project. They refer to this approach as the outside view.
Lovello and Kahneman, along with other experts such as Edward W. Merrow and Bent Flyvbjerg, have been promoting this method for years, but many forecasters continue to favor the inside view. This explains why the vast majority of projects come in over budget and past schedule, often with negative environmental, social and ethical impacts.
From my own experience in serving on several independent investment review committees, I can attest to the fact that the inside view is still the preferred method of project forecasting. Moreover, project teams are struggling to properly assess risks and their interrelationships, especially in the areas of environment, social, geopolitical and corruption.
With a poor understanding of the risks and an optimistic assessment of cost and benefits, a project can set off on the wrong foot. In this environment, it really doesn’t matter how sophisticated the controls are, creative people are likely to come up with creative, possibly unethical, solutions in order to achieve the promise made to investors and other stakeholders.
Ethical behavior doesn’t start with the first shovel in the ground; it starts at the project planning and forecasting stage.
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Troy Charlton is a Senior Advisor with Hong Kong-based Monkey Forest Consulting. He can be reached via email here.
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